Education Debt

Part 3: Loan Refinancing

Loan refinancing is the process by which a private company pays off your current loans in exchange for a new loan with new terms that they provide. The primary benefit is that the new interest rate should be lower than the rate charged by the federal government, resulting in less interest over time. If the interest rate offered is not significantly lower than your current interest rate, you probably shouldn’t be refinancing.


One of the main factors impacting the interest rate that companies will offer is the monthly payment: As the amount you’re willing to commit to paying each month goes up, the interest rate typically goes down (and vice versa). For those with a relatively low income, including most residents and fellows, the amount they are able to commit to paying each month is relatively small; thus, the benefits of refinancing federal student loans tend to be limited. However, exceptions do exist, both in the potential to decrease your interest rate without large monthly payments and in the fact that some residents can afford higher payments. In either of these cases, refinancing loans could save you money.
 

Whether or not to refinance is a personal decision. However, in general, refinancing is in your best interest if all of the following conditions are met:

Conditions under which to consider refinancing federal loans in residency

  1. You do not plan on using the Public Service Loan Forgiveness program and

  2. The interest rate offered is lower than the rate you are currently paying and

  3. You can afford the new monthly payments (which are typically higher) and

  4. You do not expect any foreseeable economic hardships over the course of your repayment period (refinanced loans are private loans; thus, cannot be placed back into deferment, forbearance, or any other government repayment plan)

Refinancing with Variable vs Fixed Interest Rates

Most companies offer both fixed and variable interest rate loans. Interest rates on fixed loans do not change over the lifetime of the loan. Variable interest rate loans tend to be offered at lower initial rates than fixed loans; however, the interest rate on a variable loan can increase or decrease over time (usually these rates are tied to an index, such as the one-month London Interbank Offered Rate or LIBOR).


There is no way to know which type of interest rate will turn out to be the cheapest. However, in general, the shorter the repayment period, the less risk a variable loan presents. For example, let’s say you had $100,000 in loans at a variable rate of 4% that jumps to and remains at 8%. The increased cost from the higher interest rate if that loan is paid off over five years is $11,160 ($110,520 at 4% vs. $121,680 at 8%), whereas the increased cost if the loan is paid off over 10 years is $24,120 ($121,440 at 4% vs. $145,560 at 8%) and over 20 years is $55,200 ($145,440 at 4% vs $200,640 at 8%). 
 

Since most residents don’t have room in their budget for payments large enough to pay off a loan in five years, they would need longer loan periods that are more vulnerable to increases in variable interest rates. For this reason, refinancing into a variable rate loan as a resident—particularly early in residency—will usually come with significant risk.
 

In summary, deciding whether to choose a fixed or variable interest rate repayment plan is personal and should be based on individual risk tolerance and the length of the expected repayment period. Factors that favor a fixed interest rate include a longer repayment period (10-plus years) and a desire to minimize risk.

Note on Refinancing:

When pricing out loan refinancing options, most companies will require you to enter personal information and will run a credit check to help determine which rates to offer you (if any).

 

Most of these credit checks will be what is called a "soft inquiry" or "soft pull," which means they will request some of the information from your credit report. These "soft pulls" will not affect your credit score.

Some lenders, however, will perform a "hard inquiry" or "hard pull" during the pricing process. "Hard pulls" will lower your credit score and typically stay on your credit report for a few years.

Therefore, when pricing out refinancing options, make sure that the company is only performing a "soft pull" in the pricing process unless you are ready to sign with the company and this is a required part of the process.

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